FUNDAMENTALS OF ECONOMICS AND MANAGEMENT FOUNDATION - Icmai.in

Micro Economics Micro economics studies the economic behaviour of individual economic units. The study of economic behaviour of the households, firms and industries form the subject-matter ofmicro economics. It examines whether resources are efficiently allocated and spells out the conditions for the optimalallocation of resources so as to maximize the output and social welfare. For example, micro economics is concerned with how the individual consumer distributes hisincome among various products and services so as to maximize utility. Thus, micro-economics is concerned with the theories of product pricing, factor pricing andeconomic welfare.Macro Economics Macro economics deals with the functioning of the economy as a whole. For example, macro economics seeks to explain how the economy’s total output of goods andservices and total employment of resources are determined and what explains the fluctuation inthe level of output and employment. It deals with the broad economic issues, such as full employment or unemployment, capacity orunder capacity production, a low or high rate of growth, inflation or deflation. It is the theory of national income, employment, aggregate consumption, savings and investment,general price level and economic growth.Interdependence between Micro Economics and Macro Economics Micro Economic analysis and Macro Economic analysis are complementary to each other; They do not complement but supplement each other. The basic goal of both the theories is same: the maximization of the material welfare of the nation. From the micro economic point of view, the nation’s material welfare will be maximized by achievingoptimal allocation of resources. From the macro economic point of view, the nation’s material welfare will be maximized byachieving full utilisation of productive resources of the economy. The study of both is equally vital so as to have full knowledge of the subject-matter of economics. The contemporary economists are concerned with both micro economics and macro economics.1.1.4 Nature of EconomicsNature of economics refers to whether economics is a science or art or both, and if it is a science,whether it is positive science or normative science or both.Economics as a Science — We have often stated that economics is a social science. Economics as a social science studies economic activities of the people. Economics is a systematic body of knowledge as it explains cause and effect relationship betweenvarious variables such as price, demand, supply, money supply, production, national income,employment, etc. Economic laws, like other scientific laws, state what takes place when certain conditions(assumptions) are fulfilled.FUNDAMENTALS OF ECONOMICS AND MANAGEMENT I 1.3

Basic Concepts of Economics This is the traditional Deduction Method where economic theories are deduced by logicalreasoning. The law of demand in economics states that a fall in the price of commodity leads to a largequantity being demanded ‘given other things’, such as income of the consumer, prices of othercommodities, etc., remaining the same. In economics we collect data, classify and analyse these facts and formulate theories or economiclaws. The truth and applicability of economic theories can be supported or challenged by confrontingthem to the observations of the real world. If the predictions of the theory are refuted by the real-world observations, the theory stands rejected. If the predictions of the theory are supported by the real-world events, then the theory is formulated. The laws of economics or economic theories are conditional subject to the condition that otherthings are equal. Economic theories are seldom precise and are never final; they are not as exact and definite aslaws of physical and natural sciences. The laws of physical and natural sciences have universal applicability, but economic laws are notof universally applicable. The laws of physical and natural sciences are exact, but economic laws are not that exact anddefinite.Economics as an Art — Various branches of economics, like consumption, production, distribution, money and banking,public finance, etc., provide us basic rules and guidelines which can be used to solve variouseconomic problems of the society. The theory of demand guides the consumer to obtain maximum satisfaction with given income. Theory of production guides the producer to equate marginal cost with marginal revenue whileusing resources for production. The knowledge of economic laws helps us in solving practical economic problems in everyday life.Economics as a Positive Science — A positive science is that science in which analysis is confined to cause and effect relationship. Positive economics is concerned with the facts about the economy. It studies the economic phenomena as they exist. It finds out the common characteristics of economic events. It specifies cause and effect relationship between them. It generalizes their relationship by formulating economic theories and makes predictions aboutfuture course of these economic events.Economics as a Normative Science — The objective of Economics is to examine real economic events from moral and ethical angles andto judge whether certain economic events are desirable or undesirable. Normative economics involves value judgment. It deals primarily with economic goals of a society and policies to achieve these goals. It also prescribes the methods to correct undesirable economic happenings.1.4 I FUNDAMENTALS OF ECONOMICS AND MANAGEMENT

Economics as a Science and an Art — Being a systematized body of knowledge and establishing the cause and effect relationship of aphenomenon, Economics is a scientific study. The laws of economics are conditional. Economics cannot predict with so much certainty and accuracy as the subject deals with thebehaviour of human beings as such controlled experiment is not possible. Some economists prefer to treat economics as an art. Every science has an art or a practical side. Every art has a scientific side which is theoretical. Economics deals with both theoretical aspects as well as practical side of many economic problemswe face in our daily life. Thus, Economics is both science as well as an art.1.1.5 Central Problem of all Economies In case of any economy, whatever the economy required cannot be satisfied fully. Economic resources or means of production are limited and they can be put to alternative uses. Every economy faces some common problems.What toproduce? A country cannot produce all goods because it has limited resources. It has to make a choice between different goods and services. Every economy has to decide what goods and services should be produced. As an economy decides to produce certain goods, it faces the problem to decidehow these goods will be produced.How toproduce? The problem arises because of unavailability of some resources. It also involves the choice of technique of production. A country may produce by labour intensive methods or by capital intensive methodsof production, depending upon its stock or man power. Goods and services are produced for people who have the means to pay for them.For whom to A country may produce mass consumption goods at a large scale or goods forproduce?upper classes. All it depends upon the policies of the government as well as private producing units.1.1.6 Economic OrganizationsIt refers to the arrangements of a country’s economy in terms of production, distribution and consumptionof goods and services.FUNDAMENTALS OF ECONOMICS AND MANAGEMENT I 1.5

Basic Concepts of Economics1.2 FEW FUNDAMENTAL CONCEPTS1.2.1 WealthBy wealth we mean the stock of goods under the ownership of a person or a nation. It means the stock of all goods like houses and buildings, furniture, land, money incash, money kept in banks, clothes, company shares, stocks of other commodities,etc. owned by a person.(i) Personal Health, goodwill, etc., can also be considered to be parts of an individual’s wealth.wealth In Economics, they are transferable goods (whose ownership can be transferred toanother person). These are considered to be components of wealth. It includes the wealth of all the citizens of the country. There are public properties whose benefits are enjoyed by the citizens of the countrybut no citizen personally owns these goods.(ii) Nationalwealth Natural resources (mineral resources, forest resources, etc), roads, bridges, parks,hospitals, public educational institutions and public sector projects of various types(public sector industries, public irrigation projects, etc.) are example of publicproperties. There is some personal wealth which is to be deducted from national wealth. Example, if a citizen of the country holds a Government bond, it is personal wealth.But from the point of view of the Government, it is a liability and, hence, it should notbe considered as a part of the nation’s wealth.1.2.2 Wealth and Welfare Welfare means the satisfaction or the well-being enjoyed by society. Social welfare depends on the wealth of the nation. In general, wealth gives rise to welfare, although they are not same. If wealth of society increases, but the distribution among the citizens of the country is very unequal,this inequality may create social jealousy and tension. Economists, however, assume that when wealth increases, welfare increases too. Similarly, when wealth decreases, welfare is assumed to decrease.1.2.3 Money Anything which is widely accepted in exchange for goods, or in settling debts. In Barter System, goods were used as medium of exchange. When general acceptability of any medium of exchange is enforced by law, that medium ofexchange in called the legal tender, (example, the rupee notes and coins). When some commodity is used as a medium of exchange by custom, it is called customary money,(example, the rupee notes and coins).Constituents of money supplyIn any economy, the constituents of money supply are as follows:(a) Rupee notes and coins with the public,1.6 I FUNDAMENTALS OF ECONOMICS AND MANAGEMENT

(b) Credit cards,(c) Traveller’s cheques, etc.1.2.4 Markets A system by which the buyers and sellers of a commodity can come into touch with each other(directly or indirectly). In Economics, a market for a commodity is a system. Here, the buyers and the sellers establish contact with each other directly or indirectly. They have a view to purchasing and selling the commodity.Functions of a marketThe major functions of a market for a commodity are : (i) to determine the price for the commodity,and (ii) to determine the quantity of the commodity that will be bought and sold. Both the price andthe quantity are determined by the interactions between the buyers and the sellers of the commodity.The market mechanismWhen economists talk of the market mechanism, they mean the totality of all markets (i.e., the marketsfor all the goods and services in the economy). The market mechanism determines the prices and thequantities bought and sold of all the goods and services.1.2.5 InvestmentInvestment means an increase in the capital stock. For a country, as a whole, investment is the increasein the total capital stock of the country. For an individual, investment is the increase in the capital stockowned by him.Real investment and portfolio investmentEconomists talk of two types of investment : real investment and portfolio investment.(a) Real investment : Real investment means an increase in the real capital stock, i.e., an addition tothe stock of machines, buildings, materials or other types of capital goods.(b) Portfolio investment : Portfolio investment essentially means the purchase of shares of companies.However, it is only the purchase of new shares issued by accompany that can properly be termedas investment (because the company will use the money for expanding its productive capacity,i.e., the company’s real capital stock will increase). Purchase of an existing share from anothershareholder is not an investment because in this case the company’s real capital stock does notincrease.Gross investment and net investmentIn any economy, the aggregate investment made during any year is called gross investment. The grossinvestment includes (a) inventory investment and (b) fixed investment. Investment in raw materials, semifinished goods and finished goods is referred to as inventory investment. On the other hand, investmentmade in fixed assets like machineries, factory sheds etc. is called fixed investment.By deducting depreciation cost, of capital from the gross investment, we get new investment.So, Net investment Gross investment – depreciation cost.1.2.6 Production Production means “creation of utility”. It also refers to creation of goods (or performance of services) for the purpose of selling them in themarket.FUNDAMENTALS OF ECONOMICS AND MANAGEMENT I 1.7

Basic Concepts of Economics There was a time when production meant the fabrication of material goods only. A tailor’s activity was considered to be production but the activity of the trader who sold clothes tothe purchasers was not considered as production. At present, both material goods and services are considered as production. Production must be for the purpose of selling the produced goods (or, services) in the market.Factors of productionThe goods and services with the help of which the process of production is carried out, are calledfactors of production. Economists talk about four main factors of production : land, labour, capital andentrepreneurship (or organization). They are also called as the inputs of production. On the other hand,the goods produced with the help of these inputs, are called as the output.1.2.7 ConsumptionBy consumption, we mean satisfaction of wants. It is because we have wants that we consume variousgoods and services. Moreover, it is assumed that, if we have wants, these can be satisfied only throughthe consumption of goods and services. Thus, consumption is defined as the satisfaction of human wantsthrough the use of goods and services.Other determinants of consumptionPresent incomeIt is the main determinant of consumptionExpected futureincome Most people try to save for the future. People display a low average propensity to consume when they are young. A low propensity to save when they are old.Wealth A person may have a low income, but he may be wealthy He may have a great amount of accumulated wealth, In this case, he may have high consumption expenditure.1.2.8 Saving Saving is defined as income minus consumption. Whatever is left in the hands of an individual after meeting consumption expenditure is theindividual’s saving. The sum-total of funds in the hands of an individual is obtained by accumulating the saving of thepast years. Saving is generated out of current income of an individual. Savings are created out of past income of an individual.1.2.9 IncomeThe income of a person means the net inflow of money (or purchasing power) of this person over acertain period. For instance, an industrial worker’s annual income is his salary income over the year. Abusinessman’s annual income is his profit over the year.Wealth and incomeThe difference between wealth and income must be clearly understood. A person (or a nation) consumesa part of the income and saves the rest. These savings are accumulated in the form of wealth. Wealthis a stock. It is stock of goods owned at a point of time. Income is a flow; it is the inflow of money (orpurchasing power) over a period of time.1.8 I FUNDAMENTALS OF ECONOMICS AND MANAGEMENT

1.2.10 Consumer Surplus The concept was introduced by Prof. Marshall in Economics. The excess satisfaction or utility that a consumer can enjoy from the purchase of a thing when theprice that he actually pays is less than the price he was willing to pay for it. It is the difference between individual demand price and market price. The price that a man is willing to pay is determined by the marginal utility of the thing to him. The concept is derived from the Law of Diminishing Marginal Utility. As a man consumes successive units of a commodity, the Marginal Utility from each unit goes onfalling. It is often argued that the surplus satisfaction cannot be measured precisely. It is difficult to measure the marginal utilities of different units of a commodity consumed by person.1.2.11 Capital In a fundamental sense, capital consists of any produced thing that can enhance a person’s powerto perform economically useful work. Example, a stone or an arrow is capital for a caveman who can use it as a hunting instrument. Capital is an input in the production process. It refers to financial resources available for use. Capital is different from money. Money is used simply to purchase goods and services for consumption. Capital is more durable andis used to generate wealth through investment. Capital is something owned which provides ongoing services. Economic capital is used for measuring and reporting market and operational risks across a financialorganization.1.2.12 Utility Utility, or usefulness, is the ability of something to satisfy needs or wants. Utility is an important concept in economics because it represents satisfaction experienced by theconsumer of a good. Utility is a representation of preferences over some set of goods and services. One cannot directly measure benefit, satisfaction or happiness from a good or service, so insteadeconomists have devised ways of representing and measuring utility in terms of economic choicesthat can be counted. Economists consider utility to be revealed in people’s willingness to pay different amounts fordifferent goods. Total utility is the aggregate sum of satisfaction or benefit that an individual gains from consuminga given amount of go

asic Concepts of Economics (c) Economics is the study of personal and social activities concerned with material aspects of well being. (d) Marshall emphasized on definition of material welfare. Herein lies the distinction with Adam Smith's definition, which is wealth centric. (iii) Scarcity definition This definition was put forward by Robbins.